Fire Sale Mergers: Why Turkeys Vote for Thanksgiving

A presentation of the dynamic as to why a majority of partners can feel compelled to vote for the liquidation of their firm through a merger into a larger one, even when it will cost them their partnership, or even employment, in the short term.

􀀊􀀙􀀠􀀁􀀌􀀟􀀌􀀔􀀖􀀌􀀍􀀖􀀐􀀁 􀀄􀀂􀀃􀀂􀀁􀀅􀀋􀀒􀀑􀀒􀀐􀀎􀀋􀀁􀀆􀀑􀀕􀀍􀀓􀀍􀀔􀀕􀀁􀀉􀀕􀀊􀀕􀀍􀀐􀀍􀀑􀀕􀀔 􀀑􀀙􀀛􀀁􀀇􀀌􀀖􀀔􀀑􀀙􀀛􀀘􀀔􀀌􀀁􀀋􀀞􀀚􀀛􀀐􀀗􀀐􀀁􀀇􀀙􀀞􀀛􀀝􀀁􀀕􀀞􀀜􀀝􀀔􀀎􀀐􀀜 􀀇􀀖􀀌􀀎􀀋􀀎􀀊􀀏􀀁􀀈􀀓􀀒􀀁􀀁􀀏􀀍􀀔􀀢􀀔􀀘􀀎􀀖􀀞􀀏􀀔􀀘􀀒􀀁􀀝􀀓􀀐􀀁􀀖􀀌􀀝􀀐􀀜􀀝􀀁 􀀐􀀎􀀙􀀘􀀙􀀗􀀔􀀎􀀁􀀔􀀘􀀝􀀐􀀛􀀐􀀜􀀝􀀁􀀜􀀝􀀌􀀝􀀐􀀗􀀐􀀘􀀝􀀜􀀢􀀌􀀟􀀌􀀔􀀖􀀌􀀍􀀖􀀐􀀁 􀀌􀀝􀀁􀀂􀀆􀀅􀀄􀀚􀀛􀀙􀀁􀀁􀀖􀀐􀀁􀀝􀀙􀀁􀀈􀀌􀀔􀀖􀀡􀀁􀀉􀀙􀀞􀀛􀀘􀀌􀀖􀀁􀀜􀀞􀀍􀀜􀀎􀀛􀀔􀀍􀀐􀀛􀀜􀀁 􀀙􀀘􀀁􀀠􀀠􀀠􀀃􀀏􀀌􀀔􀀖􀀡􀀕􀀙􀀞􀀛􀀘􀀌􀀖􀀃􀀎􀀙􀀗 On the Move Holder appoints US attorney to committee Attorney General Eric Holder appointed Laura E. Duffy of the Southern District of California to serve a two-year term on the attorney general’s advisory committee. President Barack Obama appointed Duffy as U.S. attorney in June 2010. Prior to that, she was assistant U.S. attorney in the district as deputy chief of the general crimes section. Reed Smith adds partner Reed Smith LLP added Steven S. Baik as partner in Palo Alto. He focuses on patent litigation and has counseled in patent portfolio development and offensive and defensive licensing and litigation. Baik comes to the fi rm from Freitas, Tseng, Baik & Kaufman, which he formed with three other former partners from Orrick, Herrington & Sutcliffe LLP. Munger Tolles adds of counsel Munger, Tolles & Olson LLP added Dan B. Levin as of counsel in Los Angeles. He will join the fi rm’s litigation and appellate practice effective Jan. 3. Levin comes to the fi rm from the U.S. attorney’s offi ce in the Central District, where he was deputy chief of the criminal appeals section. Best, Best & Krieger adds of counsel Best, Best & Krieger LLP added Steven E. Lake as of counsel in San Diego. He focuses on representing public educational agencies in compliance matters involving Individuals with Disabilities Education Act, section 504 of the Rehabilitation Act and the Americans with Disabilities Act. Lake returns to the fi rm after serving as senior counsel for academics and disability for the school district of Palm Beach County. He had previously worked with Best, Best & Krieger from 2006 to 2007. Shearman & Sterling promotes one Shearman & Sterling LLP promoted Dana C. F. Kromm to partner in San Francisco. She focuses on public and private mergers and acquisitions and related corporate governance matters. Kromm joined the fi rm in 2008 from O’Melveny & Myers LLP. Wilson Sonsini promotes seven Wilson Sonsini Goodrich & Rosati promoted Samir Elamrani, Tung-On Kong, James P. McCann, Scott K. Murano, Rachel B. Proffi tt, Lisa Stimmell and Michelle Wallin as partners. Elamrani is based in San Diego and focuses on intellectual property. Kong specializes in patent litigation in San Francisco. McCann focuses on real estate and environmental, and Wallin focuses on employee benefi ts and compensation, both in Palo Alto. Also in Palo Alto are Murano, Proffi tt and Stimmell, all of whom specialize in corporate and securities matters. Wendel Rosen promotes one Oakland-based Wendel, Rosen, Black & Dean LLP promoted Gregory K. Jung to partner, effective Jan. 1. He focuses on commercial litigation involving real estate, construction, insurance and intellectual property disputes. Jung joined the fi rm in 2006 from DLA Piper in San Francisco. — Connie Lopez otm@dailyjournal.com By Edwin B. Reeser Failures of large law fi rms and the consequences to all parties are closely followed and well chronicled. The pain infl icted fi nancially and emotionally upon all parties is severe, especially in bankruptcy. Unlike many business failures, law fi rm collapses seem to occur rapidly, and catch many parties, including equity partners, genuinely by surprise. One reason for this surprise, besides lack of information and disclosure from management, is the widely held belief that capable lawyers with substantial books of business don’t need to worry. The perception is partners can avoid involvement in fi rm management, work hard, and with enough business they can go anywhere, even when leaders mismanage the fi rm into bankruptcy. That assumption has now been demonstrated to be untrue in many circumstances. First, as an “insider,” the equity partner is subject to disgorging “constructively fraudulent” distributions received for a period of up to two years under federal bankruptcy law, and perhaps four years or more under some state laws. Two years of draws and year-end distributions for partners is a lot of “clawback” money. Second, ongoing client matters don’t belong to partners with the client relationship, they are assets of the fi rm. Consider Mary, an equity partner moving to a new fi rm: Under currently applicable interpretation of statutory and case law on fi duciary duty of a partner to her partnership, Mary must disgorge all profi ts from the “unfi nished business” she takes to her new law fi rm. That is a lot of “clawforward” money for Mary and her new fi rm. Law fi rms pursuing growth through lateral hiring have awakened to their direct liability exposure to Mary’s old fi rm for profi ts earned on her unfi nished business, which may take years to complete. How much should they pay Mary for that business? If Mary has a $10 million annual business inventory, where 100 percent of the profi t is disgorged to the prior failed fi rm, the answer is “not much.” That remains the answer whether Mary’s business is $2 million or $20 million per year. There are plenty of open arguments still to be heard. What is “profi t?” Should equity partners in the new fi rm receive compensation for services rendered on Mary’s unfi nished business cases? Should Mary receive compensation for her services on those cases? While those issues are worked out, in the meantime, what happens to law fi rms that want to, or in many instances need to, hire lateral talent from law fi rms that have failed, are failing or at risk of failing within the next several years (assuming one could even forecast this). Conversely, how does talent such as Mary free herself of that risk, which can damage if not destroy her portability? For both law fi rms and partners, the horrendous cost of bankruptcy, and being tied up for years in litigation with uncertain outcomes, is not a practical option. Since both suitor law fi rms and Mary are motivated to fi nd a solution, they will fi nd one, unless and until the conundrum of “unfi nished business” is resolved to eliminate it. That solution is the “fi re sale” merger. Mary’s fi rm, at the urging of Mary and her similarly situated partners, agrees to be “acquired” by a new and typically much larger law fi rm. This transaction will be more like a packaged “orderly dissolution and liquidation” effected over a couple of years. The new fi rm takes on the revolving debt of the failing law fi rm and pays it down with collection of the failing fi rm’s accounts receivable. Unlike bankruptcy scenarios where accounts receivable are collected at deep discounts, continuing businesses collect accounts at realization rates near historical experience. This can be a difference of many millions of extra dollars otherwise lost in the bankruptcy route, now available to pay creditor claims of Mary’s fi rm. The new fi rm will also take on staff, associates, and contract partners in numbers suffi cient to avoid triggering WARN Act liabilities, a “springing” liability in many law fi rm bankruptcies that can amount to millions of dollars. They will then be let go gradually, retaining only the most profi table. Furnishings, fi xtures and equipment are practically worthless in a dissolution, but they do have value in a combination as they come to the transaction “free.” Malpractice claims in bankruptcy, especially as a defense to collection actions by trustees, rise dramatically in law fi rm failures. But in mergers, malpractice claims don’t spike, saving large amounts of money. Leases of surplus space are disposed of in an orderly fashion. Even though it may be necessary to dispose of excess space at a loss, given time it can be done reasonably, and “merger” terms can place the bulk of that cost upon the failed fi rm’s partners. The costs associated with the failure in a bankruptcy are either not incurred, or born heavily by the lower end of the spectrum of staff, associates, contract partners, and those equity partners that the new fi rm doesn’t retain. Mary doesn’t even have to take responsibility for having made it happen. She didn’t fi re them, she just arranged for somebody else to do it. She keeps her income level, avoids both clawback and clawforward liabilities, and her new fi rm gets gross revenue and profi ts gains. A good deal for every one? Certainly people that lose their jobs might disagree. But for the acquiring fi rm and the acquired partners who were willing to sacrifi ce their staff and attorneys to protect their own interests, a signifi cantly better deal than bankruptcy. So, is there a catch? How do partners in the acquired fi rm feel about going to a new enterprise that is comfortable accommodating large scale culling of attorneys and staff? Do you want to be their partner? What assurance is there that you will not be on the menu soon? Should you expect to be treated any differently? If you are the acquiring fi rm, are you excited about bringing in new partners prepared to sacrifi ce so many of their own? Perhaps the answer is they all fully understand and are prepared to do it. Knowing all this, how does one get partners to vote for a deal where it is clear that signifi cant numbers will be sacrifi ced? How do you get turkeys to vote for Thanksgiving? One way is to not tell the partners in Mary’s fi rm everything. Thanksgiving is described as a future with compatible cultures, expanded platforms with breadth of service capabilities for clients, and new opportunities. The picture is carefully painted to show decorations, table settings, plates and crystal, potatoes, beans, corn, yams, stuffi ng, wine and cranberry...but not the turkey platter. Contrasted with the bankruptcy scenario, and omitting who gets to be the main course, it could lead to a solid majority vote for the “merger.” A second way is for Mary’s fi rm to make it clear that everyone is in line for the chopping block through a bankruptcy proceeding. The approach is to use the new fi rm as a refuge while partners fi nd a place they want, without the damage from a bankruptcy of their old fi rm. Turkeys vote for Thanksgiving when they plan to get off the farm before the holiday. The new fi rm will be left with little of Mary’s fi rm in a few short years, other than sunk costs in trying to do an opportunistic acquisition of key talents. Both types of arrangements have taken place in recent years. The middle and lower tier equity partners, even if they are converted to nonequity status, reduced in income shares, or counseled out of the fi rm altogether, are better off in the fi re sale merger than in bankruptcy. They avoid the clawbacks and clawforwards just as Mary does. They will likely forfeit all or some portion of their capital, but that was likely to happen in bankruptcy anyway. What is diffi cult for their class is that they will be obligated to forfeit capital in the old fi rm, and then lose their job anyway. Thus in a very real economic sense, about one-third of the equity partners in Mary’s fi rm are trading off the equity of two-third of the partners in number and the WARN Act benefi ts of others, to work the fi re sale merger that preserves their job and income status. Most of the middle and lower tier partners have had little or no involvement in the decision-making of the fi rm that brought it to failure, but they will pay for it. Now they wake up to the signifi cant difference between being invited to “have skin in the game” and “the game of being skinned” as an equity partner. Pass the cranberry, and let’s have a show of hands for all in favor of Thanksgiving. ‘Fire sale’ mergers: Why turkeys vote for Thanksgiving The costs associated with the failure in a bankruptcy are either not incurred, or born heavily by the lower end of the spectrum of staff, associates, contract partners, and those equity partners that the new firm doesn’t retain. Edwin B. Reeser is a business lawyer in Pasadena specializing in structuring, negotiating and documenting complex real estate and business transactions for international and domestic corporations and individuals. He has served on the executive committees, and as an offi ce-managing partner of fi rms ranging from 25 to over 800 lawyers in size. These 1929 amendments required the suspension of the operator’s license and registration of any motorist who failed to satisfy a traffi c accident judgment in excess of $100 for property damage or for damage in any amount on account of bodily injury or death. The suspension could not be set aside unless and until the judgment debtor paid the judgment up to certain amounts set forth in the statute and gave proof of fi nancial ability to pay any future claims based upon the negligent operation of a motor vehicle. From 1929 to 1967, the Legislature occasionally tinkered with the motor vehicle fi nancial responsibility laws, especially in 1947 and 1959. In 1947, the Legislature enacted a law that required a negligent driver who caused personal injury or death or property damage in excess of $100 to show that he or she had security or was exempt. If the negligent driver could not produce such proof, the Department of Motor Vehicles would suspend his or her license, and reinstate it only after he or she satisfi ed the judgment and provided proof of fi nancial ability to pay any future claims based upon the negligent operation of a motor vehicle. In 1959, the Legislature passed a bill requiring drivers of motor vehicles to have insurance in the form of money or its equivalent in amounts not more than $10,000 (for bodily injury to or death per person in any one accident), subject to an aggregate sum of $20,000 (for bodily injury to or death of two or more persons in any one accident). Additionally, a limit of not more than $5,000 was applied if there was injury or destruction to property of others. Then in 1967, the Legislature revised the laws to require motorists to have compulsory liability insurance (or other specifi ed means of security) of at least $15,000 for bodily injury to or death of each person as a result of any one accident, to a total of $30,000 for any one accident, regardless of how many people were injured and killed. Additionally, the law provided that the motorist must have insurance of at least $5,000 for damage to or destruction of property of others as a result of any one accident. These laws became operative on July 1, 1968 and have been the law ever since. This means that the minimum compulsory fi nancial responsibility requirements have not changed in nearly 45 years despite infl ation, the rise in the Consumer Price Index (CPI), and the diminished buying power of the dollar. Using the CPI infl ation calculator (available at http://data/bls.gov/cgi-bin/cpicalc.pl), to equal $15,000 in 1968 (when this limit was fi rst enacted), the equivalent amount in 2011 would be $97,595.26. The $30,000 maximum set in 1968 and still in force for everyone who suffers personal injury or death in the same accident, has the same buying power as $195,190.52 today. And for property damage or destruction, it would take $32,531.75 in 2011 to equal $5,000 in 1968. While the fi nancial responsibility limits have not budged since July 1, 1968, the cost of everything else has risen dramatically. Medical health care costs have soared; wages are considerably more than they were in 1968; advances in psychology and pain management can now accurately measure the amount of mental distress and pain and suffering a victim experiences; and car prices have increased tremendously, while repair costs have risen ten-fold. The primary purpose of requiring liability insurance is to protect other drivers and their passengers, bicyclists, pedestrians, and those on or near the road from a driver’s careless or drunken driving, and to provide some modicum of damages to the family or heirs of the person who is killed due to the negligence of another driver. The money is to compensate the victim for medical bills, lost wages, pain and suffering, and other tort damages to save them from fi nancial hardship or even complete ruin. The The secondary purpose of the mandatory liability insurance law is to protect the careless driver from fi nancial ruin due to his or her inattentiveness or vehicular negligence. Unfortunately, all too often the drivers operating motor vehicles who have minimum limits generally do not have suffi cient assets to satisfy a judgment or pay for injuries or wrongful deaths out of their pockets. That is why it is so vital that the automobile operator have suffi cient limits to cover the people injured or killed in his or her own vehicle, even though the driver was not at fault. Uninsured and underinsured coverage in amounts of at least $100,000 per person and $300,000 per accident are vital to protecting drivers and their passenger against those who have no or only minimum insurance coverage. At a minimum, mandatory fi nancial responsibility laws should be set at $50,000 per person, with a total of $125,000, and $25,000 property damage per accident. An interesting factoid: In 1897, Travelers Insurance Co. sold the fi rst automobile liability insurance to Gordon J. Loomis for $1,000. The policy protected Loomis if his car killed or injured someone or damaged another’s property. The author thanks Dean C. Rowan Esq., head reference law librarian at UC Berkeley Law School, for his assistance in this article. Minimum vehicle liability insurance limits must be raised This means that the minimum compulsory financial responsibility requirements have not changed in nearly 45 years despite inflation, the rise in the Consumer Price Index, and the diminished buying power of the dollar. SUBMIT A COLUMN The Daily Journal accepts opinion pieces, practice pieces, book reviews and excerpts and personal essays. These articles typically should run about 1,000 words but can run longer if the content warrants it. For guidelines, e-mail legal editor Sharon Liang at sharon_liang@dailyjournal.com. WRITE TO US The Daily Journal welcomes your feedback on news articles, commentaries and other issues. Please submit letters to the editor by e-mail to sharon_ liang@dailyjournal.com. Letters should be no more than 500 words and, if referencing a particular article, should include the date of the article and its headline. Letters may not reference a previous letter to the editor. 􀀤􀁐􀁏􀁕􀁊􀁏􀁖􀁆􀁅􀀁􀁇􀁓􀁐􀁎􀀁􀁑􀁂􀁈􀁆􀀁􀀒 SAN FRANCISCO DAILY JOURNAL MONDAY, DECEMBER 19, 2011 • PAGE 5 BRIEFLY Several telemarketers pleaded guilty Friday to federal felony charges involving taking more than $11 million from underwater homeowners seeking loan modi􀃠 cations and failing to perform the service. Defendants Gary Bobel, Scott Thomas Spencer, Mark Andrew Spencer and Travis Iverson pleaded guilty to conspiracy charges relating to wire fraud, money laundering and tax evasion, and Bobel also pleaded guilty to a separate tax evasion charge. Prosecutors said the men, while working for an Oceanside company called 1st American Law Center, used high-pressure sales tactics and lies to convince more than 4,000 struggling homeowners across the U.S. to pay between $1,995 and $4,495 for loan modi􀃠 cation services that were never furnished. A 􀃠 fth defendant in the scheme, Roger Jones, pleaded guilty to conspiracy last year and was sentenced to nearly two years in prison. Bobel, Scott Spencer and Mark Spencer and Iverson face up to 􀃠 ve years in prison on the conspiracy charge, and Bobel faces an additional 􀃠 ve years behind bars on the tax evasion charge. Sentencing is set for March 9. FREE ATTORNEY TO ATTORNEY CONSULTATION WITKIN&EISINGER,LLC NON-JUDICIAL FORECLOSURES ‘Your Trust Deed Foreclosure Specialists’ We continue to specialize in the non-judicial foreclosure of obligations secured by real property or real and personal property (mixed collateral). When your client needs a foreclosure done professionally and at the lowest possible cost, give Witkin & Eisinger a call. Richard G. Witkin Attorney at Law NATIONWIDE TOLL-FREE: 800-950-6522

Latest Posts

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

"My best business intelligence, in one easy email…"

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.

Privacy Policy (Updated: October 8, 2015):

hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide

*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.